Bankruptcy code won’t cure what ails U.S. states

By Agnes T. CraneThe author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Today, there’s no U.S. federal bankruptcy process for states — though there is for municipalities and, of course, for companies. Veteran Republican Newt Gingrich and other conservatives want to change that. So far, though, the proposal smacks of politics and ivory-tower musing rather than practical policy.

States are in a bind. Overpromising benefits to public servants, overspending and a terrible economy have spawned yawning budget deficits. And fear of defaults is making investors wary of the municipal bond market. Yet states are not as close to the brink as the headlines suggest. They have ways to close their budget gaps. Illinois, for instance, just enacted a temporary state income tax increase to cut down its deficit, while California hopes wage cuts and tax extensions will help fill its $25 billion hole.

One subtext of the Gingrich effort is that a bankruptcy process would give states a big stick with which to beat unions. But labor bosses know that if states run out of money their members may simply not get paid, so they already have an incentive to compromise — and some are already making concessions on benefits for new workers.

Further, constitutionally states couldn’t be forced to file for a federally overseen bankruptcy. And there are good reasons why they wouldn’t want to. First, there’s the cost. Even the small Californian city of Vallejo, with a population under 120,000, has spent $9.5 million in legal fees since it filed for bankruptcy in 2008 — and it’s still in court. Imagine the scaled-up cost and time for a state.

A bankruptcy would also shut a state out of capital markets. That means infrastructure projects would be mothballed and crucial financing needed to smooth out lumpy revenue would disappear. California, for example, would have to find as much as $10 billion a year just to manage its cash flows.

On top of all this Gingrich, who hopes a lawmaker in Congress will take up the cause, wants to take tax increases off the table should a state find itself in bankruptcy court. That rules out one obvious and practical way for states to tide themselves over and sounds like political dogma. And with its revenue-raising hands tied, a state would presumably need financing help from the federal government to get through years in bankruptcy. That’s surely what Gingrich wants to avoid.

While I agree with your premise, in the past, states that have defaulted have not suffered in the long term. Mississippi defaulted on bonds in the 19th Century (the bonds trade as collector’s items)and is still around. Of course, 20% of the population is on food stamps and a lot of the workforce actually is employed directly or otherwise by the federal government.
I think the proposal is unworkable – because the politicians would not have the guts to make the necessary cuts.

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